3. Select stock
For this step, we would have to open up yahoo finance and thestreet.com. The first and obvious thing to do when first picking a stock is to look at the price and the chart to see where it is at and to where it is currently heading to. Don't just look at the daily chart for the stock as this doesn't provide an accurate data for the longer term. It is best to look at the stock at the maximum time frame.
It is recommended that you look at the 5 year time span for its price movement and move down to 7 day to daily chart when you are ready to enter the trade. If you see a down trend it doesn't mean that the stock is bad, first look at where the economy was during those times and compare it with the company's current financial statement. If the financial statements are good, the reason for the price drop might be the result of another heavily battered sector caused by the economy. This might be caused by a sell off ripple effect by huge holders of other stocks trying to offset the loss by selling the good ones, click here for more on this, the focus would be on the second paragraph.
On the other hand, if you see that the financial statements are in good order but the price has been falling, this could be the perfect time to get into the stock while it is still at its lowest point. If the financial statements reflect a sour tune, then the reason for the falling trend is caused by the ability of the company to expand or to make a profit. Shorting is the best option on this scenario.
5. Market cap
The next step is to look at market cap to determine how much the entire company is worth. A stock price can't be used to compare the value of a company to another. A company whose stock is trading for only 50 cents could be worth hundreds of billions when compared to a stock trading at $1000 a share with a company market value worth 500 million. The objective here is to verify if the stock can't be easily manipulated. If a company that is worth 35 million trading at 30 cents a share is to be used by a super rich investor as a quick lunch for the week, the stock price could be easily manipulated by buying a majority of that company's stocks. This in return would make the price of that low market cap company to rise dramatically. Let's put it this way what is 28 million to you if you got 800 million in the bank?
An insanely rich investor could easily
buy a majority of the shares of this company without effort. When other "small"
investors notice the rise in price of that penny stock from 30 cents to $1.10
in 3 days or so they would jump in irrationally. This in turn would propel the
price of the penny stock higher. When the moment is right, that insanely rich investor could just dump his shares
and take profit while small investors would be left out with a price much lower
than their purchase price. A company that is worth 100 billion will take a lot
more effort to manipulate the same way as that 35 million dollar company.
6. Shares outstanding
When comparing why this company is trading for $10 and the other $50 you have to look at the published shares outstanding at thestreet.com. This way you can determine the reason why the much better company is only trading for $10. In this step we would divide the company's market cap by its shares outstanding to get the current market price. The key point here is supply and demand, the less outstanding shares the company has and is currently in high demand, the higher the chances you'll experience the catapult ride up.
7. Check P/E ratio and EPS
These metrics should not be ignored. Earnings per share is the amount of earnings the company produces in contrast with its current stock price. A high EPS states that company earnings are sky rocketing or the number of shares outstanding are just too few. A low EPS means the company is having a hard time making money or outstanding shares are just too many.
Price to earnings ratio is the summarized version of the company's financial statement in contrast with its current stock price. If investors are willing to pay up to 20 times its current earnings then it gives you a clear hint that the company is doing outstanding. Some analysts see a very high P/E as being overpriced and ripe for a trend reversal. It is best to look at the financial stements to find out yourself if the company really has that much potential or is really just overpriced.
8. Check the balance sheet
Now go to finance.yahoo.com enter the ticker symbol of the company. Once you're there scroll down and at the bottom right of the side bar, click balance sheet under financials. Were going to look at the basic hints if the company is in distress or overflowing with cash ready to expand. Look at total assets and total liabilities. Total assets should be rising and total liabilities should be declining on the period comparison as a primary check.
Next, make sure total assets
are greater than total liabilities. A company should have less liability to
clear the way for rapid expansion.
Under liabilities, write down the value of its accounts payable and short/current long term debt. So we can compare it later if the company is capable to pay its obligations with its income. The lower its short term debt the better the company is, but not all the time. If a company has a high short term debt you shouldn't worry right away until you can see that it is way inside its gross profit stated on its income statement.
9. Check income statement
Income statement provides you with information about how efficient the company is making money. For a quick calculation to see if the company is efficient in making money divide its current cost of revenue by its total revenue and subtract 1. For example using a calculator:
total revenue = 1,000,000
cost of revenue = 700,000
divide 700,000 by 1,000,000
we get 0.7
next subtract 1 with 0.7 we should
come up with -0.3
just move the decimal place two places to the left. If it has a negative in front make it positive and if the result is positive make it negative.
in our case the result is negative so we get
30%. Our profit margin is 30% which means its margin to produce profits out of its cost is 30%. If a company spends a dollar and produce a profit of 100 then it a very efficient cash generator. The higher the profit margin the better.
Now check accounts payable and short
term debt that we wrote earlier. If the gross profit can cover the amout we
wrote down then it is a good company.
If the company currently has a negative gross profit and a huge accounts payable and short term debt, that means it has to burn cash from somewhere else on its vaults like cash and cash equivalents to cover the shortage for the next period's operations. That in turn lowers total assets and increases total liabilities due to loan interests or new loans incurred by the company to keep its operations running.
10. Research, research, research
Next step is to scour news articles
involving the company to see current activities or plans that it is currently
undertaking that could affect its future
financial standings. If you hear negative news or activities on a company with limited cash supply or a company with a negative cash flow, its future stock price will be affected. If the above conditions are met then you can't pull the buy trigger.
11. Self assessment
You have researched everything about the company and even if the company's financial statements are currently unattractive, it doesnt mean that it would not be successful in a few years. If you see that a certain product would be of great use in the future then all it takes is time to boost up its financials and get on to the road to expansion. Same goes if the company is in prestine condition at the moment, competition kills a current product or service offered by the company so you also have to put in consideration possible contenders the company would face.
12. Prepare an entry and exit point
When you are satisfied with the company,
you wouldn't just buy its stock at whichever level its price might be at the
moment. You have to look at its high and low history to determine its short
term fluctuations. You wouldn't want to buy at the peak and then loose money
next week when the price goes down.
Even if you're investing for the long run you should not ignore planning which price you would enter the trade to maximize possible profits. This is where technical analysis comes into effect. Technical analysis is a great tool if combined with fundamentals. Some traders trade using pure technicals but that path is risky especially if you are a beginner. Common technical indicators that would help you enter a trade at the best possible time would be stochastics, MACD and plotting fibonacci levels. These indicators assists you on determining the psychological condition of other traders in the market.
Buy and hold may be an age old ideology in investing but what if the company turns bad in a couple of months and you're just sitting on your couch planning on what to do with the fruits of your investments. If you don't keep track of it or do more research you'll end up with nothing so researching more while the trade is open prevents you from losing more money. Plan an exit strategy as soon as you hit that buy button. For example, a company has a promising state of the art product about to be released in a few months and you bought it's stock for that cause and never did research after that. All of a sudden the company announces it would delay the release of the product due to a faulty system. The result would be a serious drop in stock price that could transform into an even more serious ordeal like an employee strike. So plan ahead before you get cooked and drop that fire and forget tactic forever.